Interest rates spike higher. Fed's efforts to check inflation prompt jump in prime rate

Mirroring a growing economy, interest rates are on the rise. Some of the nation's largest banks yesterday raised their prime interest rate by half a percentage point to 9.5 percent.

It is the second time this year the banks have raised the prime rate - the interest fee they charge their best customers. For consumers, the increase will have its greatest impact on floating rate mortgages, which are often tied to the prime rate.

The increase in the prime had been expected because the Federal Reserve Board has been tugging short-term interest rates upward over the last several weeks. On Wednesday, in testimony before Congress, Federal Reserve Board chairman Alan Greenspan warned about the dangers of inflation but said he thought the Fed's more restrictive actions would act as a brake on the economy over the next 18 months. Higher interest rates cool consumer and business demand by making it more expensive to borrow. But Mr. Greenspan indicated that if the Fed was not successful at slowing the economic growth between 2 to 2.5 percent this year, he would continue tightening rates.

Some Fed watchers interpreted this to mean interest rates are still going higher. ``If you have a bias on how strong the economy is, you have to believe there will be more tightening by the Fed coming up,'' says Brian Fabbri, chief economist at Thomson McKinnon Securities. Of particular concern to economists is the sharp drop in the unemployment rate, which was reported at 5.3 percent last week. This job data could indicate the economy is expanding too fast.

An indication of how strong the economy is will come today when the government releases the merchandise trade deficit for May, the producer price index for June, and the June industrial production report. The consensus is for a 0.5 percent increase in prices, reflecting the higher cost of bulk commodities such as chemicals, papers, and steel, as well as the first impact of the drought on food prices. Any increase higher than 0.5 percent could be viewed negatively by the financial markets.

In fact, some bond traders are also concerned that the trade numbers will show the export side of the economy growing at a rate that will stretch the capacity limits of US manufacturing. But many companies are finding it hard to hold price increases, indicating there is still enough capacity to meet demand, says Lincoln Anderson, economist at Bear Stearns. ``We don't see any inflation pressures.''

After this week, the Fed will be watching another indicator of the economy's strength - the preliminary gross national product numbers for the third quarter, which are released in August.

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